Confidence among European chief executive officers is declining to the lowest level since the financial crisis, based on share repurchases falling to a three- year low and the disappearance of mergers and acquisitions.
Buybacks minus equity sales will fall by 67 percent to less than 10 billion euros ($13 billion) in 2012 even as cash held by Stoxx Europe 600 Index (SXXP) companies climbed to a record last quarter, data compiled by Bloomberg and UBS AG show. That would mark the smallest total since 2009, when equity offerings exceeded repurchases. Takeovers slumped to a two-year low of $92 billion last quarter, the data show.
Bears say the refusal to do more to reward investors with higher share prices means the rally that has added about $1 trillion to European equity values in 2012 will diminish as the recession worsens. Bulls say the best time to buy is when CEOs are most pessimistic and that the record 572 billion euros on corporate balance sheets combined with the lowest borrowing costs on record will spur buyouts when the economy improves.
“The concern is, what if we go back and we have another 2008?” Russ Koesterich, chief investment strategist for BlackRock Inc.’s iShares unit, said in London on Oct. 10. The firm oversees $715 billion in exchange-traded funds. “Having an excessive liquidity buffer has become the corporate equivalent of having a safety blanket.”
The Stoxx 600 fell 1.7 percent to 269.43 last week as the International Monetary Fund cut global growth forecasts. Gross domestic product in the 17-country euro area economy will shrink 0.4 percent this year, 0.1 percentage point more than predicted in July, the IMF said on Oct. 9. The recession comes three years after the global credit crisis spurred a five-quarter European contraction that erased 5.4 trillion euros of equity value.
Equities have rallied in 2012 even as the economy sputtered. The Stoxx 600 has gained 10 percent in 2012, leaving it 33 percent below its seven-year high in June 2007, after the European Central Bank pledged to buy an unlimited amount of bonds to stop credit markets from freezing and save the euro. The gauge rose 0.5 percent to 270.8 at the close of trading today. The MSCI All-Country World Index (MXWD) has also advanced 10 percent and is 23 percent below its record.
Executives have never had more scope to compensate shareholders. Cash at non-financial companies in the Stoxx 600 more than doubled since 2003, according to data compiled by Bloomberg. At the same time, CEOs can borrow at interest rates almost a full percentage point less than they pay in dividends, making it more attractive for firms to take on debt to cancel shares and cut the total payout to stockholders.
The yield on the Barclays Pan-European Aggregate Corporate index of company debt fell to 2.75 percent last week, compared with 4.7 percent at the start of the year. Companies in the Stoxx 600 pay out about 4 percent of their share price in dividends.
European companies could raise as much as 560 billion euros in debt to acquire stock without jeopardizing investment-grade credit ratings, an Oct. 4 study by Citigroup Inc. showed.
That hasn’t prevented companies from AstraZeneca Plc (AZN) to Royal KPN NV and Telefonica SA (TEF) from stopping share repurchases. Goldman Sachs Group Inc. said in a Sept. 27 note that companies such as Metro AG (MEO) in Dusseldorf would benefit from buybacks because its equity is yielding more than four times as much as its bonds.
“Confidence never reached European executives,” said Valentijn van Nieuwenhuijzen, who helps oversee $369 billion as head of tactical asset allocation at ING Investment Management in the Hague. “Unless corporate boardrooms perceive that there is a genuine probability of strong end-demand, they will remain hesitant.”
Announced takeovers by western European companies fell to $95 billion in the three months through September, 11 percent less than the same period last year, according to Bloomberg data. The volume peaked at $609 billion in the second quarter of 2007, the data show.
Economic data in Europe has worsened. A report on Oct. 8 showed German industrial production declined 0.5 percent in August after expanding 1.2 percent the month before, while business confidence in the country unexpectedly fell to the lowest in more than 2 1/2 years last month, the Ifo Institute in Munich said Sept. 24.
Unemployment in the euro area has held at a record 11.4 percent for three months. In the U.S., it has declined to 7.8 percent from 10 percent in October 2009, according to Labor Department data. Sales per share in the Stoxx 600 will be 308.15 euros this year, a 3 percent increase from 2011, more than 12,000 estimates compiled by Bloomberg show. Revenue may grow 4 percent in 2013, the data show.
Buybacks by American companies have also declined, though at half Europe’s rate. U.S. repurchases slipped 38 percent to $245.4 billion. Mergers with a U.S. firm as the bidder totaled $212.6 billion in the third quarter, down 23 percent from a year earlier. Standard & Poor’s 500 Index companies issued $61.1 billion of shares so far in 2012, Bloomberg data show.
AstraZeneca canceled buybacks on Oct. 1 so the company’s new leaders would have time to prepare a strategy, Sarah Lindgreen, a spokeswoman, said in a phone interview on Oct. 11. AstraZeneca kept its profit guidance for 2012 unchanged on Oct. 1. The action is “a prudent step that maintains flexibility,” CEO Pascal Soriot said in a statement on Oct. 1, his first day on the job.
AstraZeneca had repurchased $2.3 billion of stock this year, compared with an initial target of $4.5 billion, according to the Oct. 1 statement. KPN, the largest Dutch phone company, said on Jan. 24 that it won’t buy back equity in 2012 after last year’s 1-billion euro program because it needs to balance investments with a “prudent financing policy in a period of macroeconomic uncertainty.”
Telefonica in Madrid, Europe’s second-largest phone company, canceled its 2012 share buyback plans in July in response to Spain’s three-year debt crisis. The company also scrapped its dividend and cut compensation for top executives.
The weighted average cost of debt for Metro is 1.5 percent, compared with a dividend yield of 6.7 percent, Bloomberg data show. Olaf Koch, the CEO of Germany’s biggest retailer, has done no buybacks and a spokesman who asked to remain unidentified, citing company policy, said none are planned.
“People are to some extent sitting on their hands,” Gervais Williams at Mam Funds Plc in London, whose Diverse Income Trust Plc has gained 29 percent in 2012, said in an interview on Oct. 11. “The underlying cash-generative ability of corporates is probably going to come under pressure. So I can quite see why a chef executive might be wanting to play it safe at the moment.” His company oversees $2.8 billion.
Still, spending by CEOs is likely to pick up and investors should be buying now, said Scott Minerd, who helps oversee $160 billion as managing partner at Guggenheim Partners LLC in Santa Monica, California. Valuations for Stoxx 600 companies reached 14.3 times forecast earnings in 2007 as executives spent almost 70 billion euros on buybacks and takeovers, Bloomberg and UBS data show. That’s 19 percent higher than the current ratio.
UBS estimates that equity repurchases net of new issuance will rise to more than 22 billion euros in 2013.
“Once we get past some of the uncertainties that we are living with today, it will become compelling to start considering spending money,” Minerd said in an interview on Oct. 11. “Whether you hand the money back to shareholders or acquire another company, it provides a lot of fuel to keep the market going higher.”
CEOs in Europe are finding it easier to raise money and should consider spending it on their shares, according to the Goldman Sachs note. European non-financial companies issued $49 billion of bonds denominated in euros and pounds in September, the highest amount since May 2009 and more than double this year’s monthly average, Bloomberg data show.
In Europe, “a key ingredient for the next stage of the recovery is the return of private-sector confidence,” Michael Quach, who helps oversee $19 billion at Smith & Williamson Investment Management Ltd. in London, said in an interview on Oct. 12. “We need to see some animal spirits from executives.”
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